Expectations Under a Flexible Exchange Rate System

D

Since a high yield on investments will attract capital, the nation will run a capital account surplus which must be offset by a current account deficit.

Under a flexible exchange rate system, a nation that offers more attractive investment opportunities than its trading partners can expect to run a:

C. surplus on current account transactions.

Explanation: In a flexible exchange rate system, the exchange rates between currencies are determined by market forces of supply and demand. This means that the exchange rate can fluctuate based on various factors, including relative interest rates, inflation rates, and perceived investment opportunities in different countries.

When a nation offers more attractive investment opportunities than its trading partners, it tends to attract foreign investors who seek to invest in that country's assets such as stocks, bonds, real estate, and businesses. These investments are considered capital account transactions, which represent the flow of funds for investment purposes.

As foreign investors bring capital into the country to take advantage of these opportunities, they need to exchange their currency for the local currency, increasing the demand for the local currency and, consequently, its value. This leads to an appreciation of the local currency relative to other currencies.

The surplus on current account transactions occurs because of the following reasons:

1. Increase in exports: When a nation has attractive investment opportunities, it often indicates a strong and growing economy. This can lead to increased demand for the nation's goods and services, resulting in higher exports. Higher exports contribute to a surplus on the current account as it represents the balance of trade in goods and services.

2. Decrease in imports: With a strong and growing economy, domestic consumption may increase, leading to a decrease in imports. If the nation can meet its domestic demands with its own production, it will import less from its trading partners. This decrease in imports also contributes to a surplus on the current account.

Overall, the combination of increased exports and decreased imports due to the attractiveness of investment opportunities leads to a surplus on the current account. Therefore, option C, "surplus on current account transactions," is the correct answer.